By John Gallagher Detroit Free Press
WWR Article Summary (tl;dr) When it comes to keeping a business up and running, "Cash is King."
Detroit Free Press
Probably everyone has at least daydreamed of starting their own business. A trendy restaurant, a vintage clothing shop, striking it rich with a new killer phone app -- these are the dreams that keep entrepreneurs in the game.
But a new study released this week shows that however creative the concept, small business owners often lack the financial literacy to understand what they're getting into. And that's a big reason why something like half of all small businesses fail within about five years.
"Small businesses don't fail because it's a bad business. They fail because of cash flow problems," Chris Wheat, director of business research for the JPMorgan Chase Institute and the lead researcher on the study, told me this week.
The study, titled "Growth, Vitality, and Cash Flows: High-Frequency Evidence from 1 Million Small Businesses," is based on data from business accounts held at JPMorgan Chase, the nation's largest bank and an important backer of small-business education programs here in Detroit.
To boil down a mountain of data, the study reports that holding a cash buffer remains crucial to survival for a small business. Also critical is understanding the pattern of cash flow -- money in versus money out.
Some types of businesses see more volatile cash flow patterns than others. Case in point: Restaurants. The life expectancy of a restaurant among the JPMorgan Chase account holders is just 3.7 years, the shortest of 12 industries studied.
Least life expectancy Restaurants can be victimized by the double whammy of unexpected expenses and uneven revenues. Expenses can vary because they're buying supplies all the time at often rapidly changing prices; and revenues fluctuate according to the day or the season. That pinches the amount of cash they have on hand, as evidenced by the amounts in their bank accounts, Wheat said.
"Restaurants we consistently find have more pronounced small business challenges," he said. "Restaurants tend not to be holding a lot of cash in their accounts. And if you put that together with any amount of volatility, it's not surprising to see they have the highest likelihood of exiting."
Detroit has seen a restaurant boom in recent years, especially in the greater downtown area, where dozens of burger joints, coffee shops, cafés, and high-end eateries have opened. Some are already closing, like the recently announced demise of Antietam, a highly rated restaurant near Eastern Market whose owner blamed market conditions for the close.
Longest life expectancy On the other end of the spectrum, real estate firms enjoy the longest life expectancy -- nine years. They benefit from the opposite pattern that afflicts restaurants. Both revenues and expenses tend to be more stable and predictable in the real estate world, so it's easier to keep a cash buffer.
Metro Detroit, by the way, enjoys a longer than average life expectancy for its small businesses. The median life-span of a small U.S. business is 5.3 years; in Detroit, it's 5.5 years, although the reasons are not entirely clear. Wheat said more research must be done on that question, but he suspects it has something to do with the industry mix here.
The policy implications of all this are clear. More financial literacy is the key to small-business survival.
Southeast Michigan in recent years has benefited from a wealth of training and mentoring opportunities for entrepreneurs. There are business incubators like TechTown in Detroit and Ann Arbor SPARK, training regimes like the Goldman Sachs 10,000 Small Businesses program, technology transfer offices at local universities that help commercialize important research, and much more.
Small business owners ought to take as much advantage of these programs as they can. It takes more than wishing and hoping to make a dream come true.
How long small businesses last in U.S. Real estate: 9 years Health care services: 8.8 years High-tech manufacturing: 6.9 years Other professional services: 6.5 years Metal and Machinery: 6.4 years High-tech services: 6.2 years Construction: 5.1 years Personal services: 4.9 years Wholesalers: 4.7 years Repair & maintenance: 4.6 years Retail: 4 years Restaurants: 3.7 years
Source: JPMorgan Chase Institute research